BIR Ruling No. 194-13

May 21, 2013 BIR RULING NO. 194-13 Republic Act No. 7916; RR 11-05; BIR Ruling No. 14-2012 Nonato & Nonato Law Offices Tulips Center, A.S. Fortuna St., Mandaue City, Cebu Attention: Rester John L. Nonato Counsel for Philippine Makoto Corporation Gentlemen : This refers to your letter dated June 28, 2010, requesting on behalf of your client, Philippine Makoto Corporation ("PMC" for brevity), for confirmation of your opinion that: 1. PMC's repair and maintenance costs referring to labor and materials used for machines and facility maintenance in production and manufacturing are direct costs deductible in the computation of the 5% special tax imposed on its gross income; 2. PMC's insurance expenses in relation to the insurances on importation of incoming raw materials and equipment used in production, and insurances against fire and product liability of the raw materials and warehouse used in production will be allowed as deduction in the computation of the 5% special tax imposed on its gross income; 3. PMC's subcontracting costs referring to payments to subcontractors for the performance of the subcontracted functions related to the registered activities are allowed as deduction in the computation of the 5% special tax imposed on its gross income; and 4. PMC's indirect labor costs referring to the salaries, allowances, and other benefits of quality control, engineering and warehouse production supervisors and leaders, are allowed as deduction in the computation of the 5% special tax imposed on its gross income. SaHTCE It is represented that PMC, with Tax Identification Number 003-584-239-000, is a corporation duly organized and existing under Philippine laws, with corporate address at Mactan Export and Processing Zone 1, Pusok, Lapulapu City, Cebu; that it registered with the Philippine Export Zone Authority ("PEZA") as an Economic Export Enterprise with PEZA Certification of Registration No. 93-47, dated October 1, 1993; that the scope of its registered activity is limited to the manufacture of aluminum (diecasting) body and other mechanical component parts of prismatic binoculars, specifically the right and left parts of the binoculars, and the central axis of aluminum for export and the importation of raw materials, machineries, equipment, tools, goods, wares, articles or merchandise directly used in its registered operations at the Mactan Export and Processing Zone; and that it is currently paying the 5% preferential tax on gross income earned in lieu of all other local and national taxes, on its registered activities. It is further represented that, as part of its operations, PMC incurs repair and maintenance costs referring to labor and materials used for machines and facility maintenance in production and manufacturing and that in order to meet the demand of its clients, PMC needs to ensure that the properties or machineries used are not only in good-running condition, but are likewise primed for the specific task that they are to function; that PMC also incurs insurance expenses in relation to insurance of importation of incoming raw materials and equipment used in production, and also insurance against fire and product liability of the raw materials and warehouse used in production; that PMC incurs subcontracting costs referring to payments to subcontractors for the performance of the subcontracted functions related to the registered activities; that PMC also incurs indirect labor costs that refer to the salaries, allowances, and other benefits of quality control, engineering and warehouse production supervisors and leaders; and that these expenses are necessary in order for PMC to perform its registered activities with PEZA. In reply, please be informed that Sec. 3 of Revenue Regulations (RR) No. 11-2005 dated April 25, 2005, implementing R.A. 7916, defines "gross income earned" as follows: SCHcaT "SEC. 3. Gross Income Earned. For purposes of implementing the tax incentive of registered Special Economic Zone (ECOZONE) enterprises in Section 24 of Republic Act No. 7916, the term 'gross income earned' shall refer to gross sales or gross revenues derived from business activity within the ECOZONE, net of sales discounts, sales returns and allowances and minus costs of sales or direct costs but before any deduction is made for administrative, marketing, selling and/or operating expenses or incidental losses during a given taxable period." The above definition is reduced to the following formula: Gross sales/revenues xxxx Less: Sales Discounts xxxxx Sales Returns/Allowances xxxxx Direct costs (cost of sales) xxxxx Other Manufacturing Costs xxxxx xxxx Gross taxable income xxxx The same Section also provides for a list of direct costs deductible from gross income for purposes of determining the taxable base, to wit: "For purposes of computing the total five percent (5%) tax rate imposed, the following direct costs are included in the allowable deductions to arrive at gross income earned for specific types of enterprises: 1. ECOZONE Export Enterprises, Free Trade Enterprises and Domestic Market Enterprises: Direct salaries, wages or labor expenses Production supervision salaries Raw materials used in the manufacture of products Decrease in Goods in Process Account (Intermediate goods) Decrease in finished Goods Account Supplies and fuels used in production Depreciation of machinery and equipment used in production, and of that portion of the building owned or constructed that is used exclusively in the production of goods ETAICc Rent and utility charges associated with building equipment and warehouses used in production Financing charges associated with fixed assets used in production the amount of which was not previously capitalized xxx xxx xxx" It is clear from the foregoing that the expenses, such as, the repair and maintenance costs, insurance expenses, subcontracting costs and indirect labor costs, are not allowable deductions for purposes of computing the five percent (5%) gross income tax. In BIR Ruling No. 014-2012 dated January 4, 2012, this Office held that the above enumerations are exclusive under the legal maxim unius est exclusio alterius , the mention of one thing implies the exclusion of another thing not mentioned. If a statute enumerates the things upon which it is to operate, everything else must necessarily and by implication be excluded from its operation and effect ( Tolentino vs. Paqueo , 523 SCRA 377). In the same vein, where the terms are expressly limited to certain matters, it may not, by interpretation or construction, be extended to other matters ( Sarmiento III vs. Mison , 156 SCRA 549). The rule proceeds from the premise that the legislature would not have made specified enumerations in a statute had the intention been not to restrict its meaning and to confine its terms to those expressly mentioned ( Romualdez vs. Marcelo , 497 SCRA 89). It is likewise noteworthy to mention that a deduction for income tax purposes, by its nature, is equated to exemption, hence construed strictly against the taxpayer. An item of expense should not be based merely on the assertion of the taxpayer but should be supported by convincing evidence to pass the test of deductibility. In the case of Commissioner of Internal Revenue vs. Isabela Cultural Corporation, G.R. No. 172231 dated February 12, 2007, the Supreme Court ruled in this wise: "Corollarily, it is a governing principle in taxation that tax exemptions must be construed in strictissimi juris against the taxpayer and liberally in favor of the taxing authority; and one who claims an exemption must be able to justify the same by the clearest grant of organic or statute law. An exemption from the common burden cannot be permitted to exist upon vague implications. And since a deduction for income tax purposes partakes of the nature of a tax exemption, then it must also be strictly construed." Such being the case, in the absence of a specific grant of law or rules, the repair and maintenance costs, insurance expenses, subcontracting costs and indirect labor costs incurred by PMC are not deductible in computing the preferential tax rate of 5% on its gross income as a PEZA-registered enterprise. Please be guided accordingly. Very truly yours, (SGD.) KIM S. JACINTO-HENARES Commissioner of Internal Revenue